The Federal Reserve’s latest financial report showed it had a very profitable year in 2013, resulting in another big cash infusion for the U.S. Treasury but also raising questions about whether the central bank could post big losses someday when interest rates rise. New research by three economists at the San Francisco Fed should ease such worries.

The Federal Reserve building.

Bloomberg News

While it is possible the Fed may lose money when interest rates increase, it is pretty unlikely, according Jens Christensen, Jose Lopez and Glenn Rudebusch, in an “Economic Letter” posted on the San Francisco Fed website Monday. The authors wrote the probability that what are now large Fed surpluses might turn into deficits is just 0.1%. They added there is only about a 5% chance the Fed won’t make enough money to return excess profits to the Treasury, as it currently does, between 2016 and 2018.

The Fed earns interest on its $4.3 trillion portfolio of securities, which has grown rapidly in recent years because of a series of bond-buying programs aimed at stabilizing the financial system and boosting growth. The Fed uses some of its income to cover its operating expenses and sends much of the rest to the Treasury’s general fund, where the money is used to pay government bills. The Fed sent the Treasury $79.6 billion in profits last year, down from the record $88.4 billion delivered in 2012, the central bank reported earlier this month.

The San Francisco researchers identify two kinds of risk to the Fed’s finances from rising interest rates. First, the market value of the Fed’s bonds and other assets could fall, but they note such losses “would only become realized if the securities were sold.” Fed officials have indicated they are more inclined to let the bonds mature over time rather than sell them.

A second risk is that the Fed’s expenses could shoot higher, specifically the interest it pays on excess bank reserves parked at the central bank. A large enough increase might mean the money the central bank pays out could outstrip what it is taking in from its holdings.

While the central bank can operate at a loss without needing to be bailed out by the Treasury due to its accounting rules, it could be a politically uncomfortable situation. Some Fed officials have warned of a significant political backlash that could potentially compromise its independence.

The possibility of losing money is “a secondary consideration for central banks—subordinate to the macroeconomic goals of monetary policy,” the San Francisco researchers said. Still, they concluded, “our analysis shows that the likelihood of significant losses on the Fed’s Treasury portfolio or a long cessation of Treasury remittances is very low.”

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